The future of retail in Hong Kong

Wednesday 15 January 2020

Article

We have now seen ten consecutive months of double-digit year-on-year retail sales declines in Hong Kong. Retailers are wondering if there will be a recovery soon and how much recovery they can expect. They are starting to look at their options: “What is my mid-to-long term revenue outlook? How many stores do I really need? How do I become less dependent on Chinese tourists?” The answers to these questions will have a long-lasting impact on Hong Kong’s retail environment and Hong Kong’s future as a shopping destination.

Hong Kong always recovers?

There is an optimistic view that landlords aspire to because they don’t want to see a slide in commercial leases, by which “Hong Kong always recovers”…as it did from the 1997 Asia Financial crisis, SARS epidemic, the 2008 global financial crisis, the 2014 Umbrella Movement, and so it will again from the recent crisis.

The argument for this optimistic view is that once the short-term disruptions – financial crises, demonstrations, exchange rate shifts – are over, everything goes back to normal, as it has in the past. However, our view at OC&C is that there are several structural factors that will make a full recovery and “return to normal” very difficult this time.

First and foremost, the power of the internet. As indicated by numerous consumer surveys, Chinese consumers don’t shop for anything before they have researched it online: products, prices, KOL advice, friend recommendations, etc…and they do the same before they travel, figuring out where is the best location to shop before they go on a trip using websites like Jessica’s Secret.

This has created a very transparent world where excessive price differences have become unacceptable. Brands have figured this out, and they have all adjusted their global pricing strategies to limit the extent of pricing differences for the same product across markets. These adjustments have been facilitated by reductions in import tariff and VAT. As a result, price differences between China and Hong Kong which used to be massive – ranging from 50% to 80% – have now been reduced to a modest 10% to 15%.

How far would Chinese consumers travel to benefit from a 50% to 80% price difference? Basically from anywhere…from as far as Beijing, Chengdu and Harbin. How far would consumers travel to benefit from a 10% to 15% price reduction? Perhaps just from Shenzhen, Zuhai and maybe Guangzhou.

Changing demographics of Chinese tourists to Hong Kong

The implications of this simple observation are quite deep: Visitors from remote locations, once they have visited Hong Kong once, are unlikely to return to Hong Kong just for shopping, as much as they did in the past. Instead, they are now travelling to other more “exotic” destinations in Asia, Europe and Americas.

Visitors from remote locations that are still coming to Hong Kong may include a higher proportion of first-time visitors, and these first-time visitors are likely to come from lower income groups and/or lower Tier cities, with less spending power.

Conversely, visitors from nearby locations will be more tempted to come back to Hong Kong more frequently for shopping because it is a shorter trip, facilitated by high speed trains and road bridge links, but for shorter stays. In recent years, the number of same-day visitors has been growing six times faster than the number of overnight visitors to Hong Kong.

The bottom line for Hong Kong’s retail sector

Fundamentally, Hong Kong is not as attractive a shopping destination as it used to be. Recent disruptions have accelerated the pace of an evolution in Hong Kong’s retail sector which we see as a deeper, structural shift. As a luxury brand Executive whom we recently interviewed in Hong Kong puts it: “What has happened in Hong Kong during the last 6 months is just an acceleration of what we were anticipating to see over the next 3 to 5 years”.

To cope with this underlying change, brands and retailers in Hong Kong must adjust their store footprint in line with more modest business ambitions in the market. This is probably the rationale behind LV’s recent decision to close a store in Times Square, even if this decision may have been facilitated by an inflexible landlord unwilling to cut rent.

Brands should also adjust their product assortment to cater to lower-spending visitors and focus more efforts to appeal to Hong Kong residents, in terms of product offerings, services and loyalty programs.

For landlords and mall operators, it is crucial to find ways to boost their customer attractiveness by introducing more trend-setting brands (e.g. recent openings of Sephora and Brandy Melville in IFC), as well as F&B and entertainment options that may appeal more to local residents (e.g. M&S Food). Hong Kong landlords have always been quite active on this front. By shifting their focus from big box tenants to smaller tenants, they multiply opportunities to create newness and excitement. The recent split of the Zara store in IFC into three smaller outlets including Sephora and a smaller Zara is a good illustration of this trend.

In doing so, landlords are not only improving mall attractiveness, they are also maximizing average rent yield because smaller units typically pay higher rent than larger ones. But this strategy has its limits: once big brand anchor tenants have shrunk or left, and all units are down to a minimum size, it will become harder to fight against an irresistible trend toward lower rent levels.

Lastly, landlords must also prepare to become more aggressive in competing with other malls on marketing, promotions and events. To do this will require addressing two key challenges:

  • Become much more knowledgeable about their customers through deeper collaboration and exchange of data with their tenants
    Engage with customers more proactively through smarter membership programs, including online interactions and partnerships, to keep attracting them back to their malls and to their tenants’ stores
  • As echoed by one of Hong Kong’s largest mall operators we recently interviewed, “unfortunately most landlords are way behind when it comes to capturing customer data and developing meaningful membership programs, and they will need significant investment in technology and capabilities if they want to catch up.”

Experts in this insight:

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